Good day. And welcome to the Aetna's Investor Relations Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Mr. Jeff Chaffkin. Please go ahead, sir.

Jeffrey A. Chaffkin

Good morning. And thank you for joining in the second quarter 2009 earnings call and webcast on such short notice. Given our results we thought it was important to communicate with you as soon as possible. This is Jeff Chaffkin, Head of Investor Relations for Aetna and with me this morning are Aetna's Chairman and CEO, Ronald Williams; Mark Bertolini, President; and Joe Zubretsky, Executive Vice President and Chief Financial Officer.

Following their prepared remarks we will respond to your questions. During this call we'll make forward-looking statements. Risk factors that may impact our statements and could cause actual future results to differ materially from currently expected results are described in Aetna's 2008 10-K, our first quarter 2009 10-Q and our second quarter 2009 10-Q we've filed with the SEC.

Pursuant to SEC regulations G, we've provided reconciliation of metrics related to the company's performance and non-GAAP measures in our second quarter 2009 earnings press release, second quarter 2009 financial supplement and 2009 guidance summary. These reconciliations are available on the investor information portion of aetna.com website.

Also as you know regulation-FD limits Aetna's ability to respond to certain enquiries from investors and analysts in non-public forms. So Aetna invites to you to ask all questions of material nature on this call.

With that I'll turn the call over to Ron Williams. Ron.

Ronald A. Williams

Good morning. Thank you Jeff. And thank you again for joining us today on short notice. We accelerated the timing of call to communicate our second quarter financial results, action plans and revised 2009 outlook to you as early as possible and to underscore our sense of immediacy and resolve. We have already begun implementing the corrective actions necessary to achieve future profitable growth with particular emphasis on our operating margins.

This morning, we reported second quarter operating earnings per share of $0.68, compared to our previous guidance of $0.76 to $080. We also revised our full year operating earnings per share outlook to a range of 2.75 to $2.90 from 3.55 to $3.70. This material change in outlook is due primarily to a significant increase in our commercial medical benefit ratio compared to the projection we provided to you in early June.

This was due to June results for current and prior periods that was very unfavorable, relative to expectations. Our revised outlook is consistent with this recent most information and reflects continued upward pressure on commercial medical costs beyond the level we've previously projected on June 2nd as well as premium yields insufficient to keep pace with this higher medical cost.

I am disappointed in our second quarter results and our revised 2009 outlook. This performance is not inline with the track record we have established over several years of strong operational execution and financial performance. This morning we will discuss the drivers of our results and revised outlook from both an operation and financial perspective. More importantly we will discussed the decisive actions we are taking to reposition ourselves for success going forward.

With high insight, we did not fully anticipate the impact that macro economic and marketplace forces would have on our business. As we now have a complete view of second quarter 2009 reported medical cost experience, including unfavorable prior period reserve development, our first quarter 2009 and 2008, dates of service, we now know that our 2008 commercial medical cost baseline was higher than we projected.

Our 2009 trend is higher than we projected and our 2009 pricing was insufficient to cover these higher medical costs. We are taking the decisive yet powerful actions to put these execution challenges behind us and regain our momentum.

These actions include: better execution in achieving target underwriting margins and more conservative bias toward forecasting and pricing; increasing the frequency and intensity of medical cost management processes while insuring that member receive high quality cost effective care; implementing provider contracting and reimbursement initiatives to ensure consistency with evidences based clinical protocols and to address some of the provider behavioral shifts we've seen. And adjusting our operating costs structure to align with our revised earnings profile while still investing for future profitable growth.

We believe these actions and a more conservative outlook will lead to more stable and predictable future results. In a moment Joe will discuss our second quarter financial performance in 2009 outlook. Mark will then provide more insight into the actions we are taking to improve our underwriting margins. I want you to know that these matters have my full attention and that of my entire senior team. I am confident we have the management expertise and organizational capability to get the job done. We have our best talent addressing our most significant challenges to ensure that we are focused on improving our operating margins.

We would be wiling to forgo membership growth if necessary to do so. We have a clear bias toward profitability over growth. Our near-term focus is on operational execution. We also continue to strategically position our franchise for the future. The expansion of our Aetna One integrated platform is on track. We continue to experience a great deal of interest in Aetna One and we expect to convert additional existing ASC members onto the new platform as of January 1.

We are particularly honored to have been selected by the United States Department of Defense to become the managed care support contractor and for the TRICARE North Region effective April 1st 2010. We are proud to have been chosen as the Service Provider of Choice in this region. It underscores our operational and medical management capabilities as well as the overall value we bring to the marketplace.

I continue to have a great deal of confidence in our long-term future. We have a sound strategy. We have a robust product suite that includes benefits designs, product features and price points that continue to meet the needs of our customers. Even with trend increases that reflect our most recent experience, we believe our premium rates remain market competitive. Our financial strength continues to be excellent and we continue to generate excess cash flow to redeploy to drive future earning per share growth.

I'll now turn the call over to Joe Zubretsky to provide insight into our second quarter financial performance and an outlook for 2009. Joe?

Joseph M. Zubretsky

Thank you, Ron. Earlier today we reported second quarter operating earning per share of $0.68, a decrease of 28% from the prior year quarter. This was a result of two factors, a 34% decrease in operating earnings to $309 million driven primarily by lower than projected commercial underwriting margin partially offset by the favorable impact of capital actions. We indicated on a June second guidance call that the current operating environment entails higher than normal risks including the potential for increased variability in our medical benefit ratios.

We have seen this risk materialized, in particular June commercial medical costs result for second quarter and prior period emerged much less favorably than our previous projections and caused us to change our full year projections for 2009.

I will now discuss the drivers of our second quarter financial performance starting with operating margin and its key components. Second quarter business segment operating margin was 7% before tax, a year-over-year decrease of 270 basis points. The primary downward forces on a year-over-year basis were to higher than projected commercial medical benefit ratio and the previously disclosed revision to Medicare risk adjusted premium. These were offset by a 160 basis point improvement in our business segment operating expense ratio.

While our second quarter results were burdened with prior period items the pro-forma operating margin profile is still not at our target levels. We are committed to improving our margins to the high single digit range over the next two to three years. Second quarter revenue growth was driven by 11.2% year-over-year increase in health care revenue which resulted from an 11.8% growth in health care premium and a 7.4% increase in health care fees and other income. Health care premium growth reflects commercial premium growth of 8.4% resulting from 5% volume growth in a yield increase of 5%, partially offset by a 2% decline from the effect of product mix, 18.7% Medicare premium growth and 73% growth in Medicaid.

Our second quarter total medical benefit ratio was 86.8% which included $65 million before tax of unfavorable prior period reserve development, 49 million of which was related to 2008 dates of service. In total, with the experience through the second quarter our view of 2008 prior year reserve development is approximately $100 million before tax. This has a compounding impact on 2009 results.

Our commercial medical benefit ratio was 85.9% in the second quarter. Excluding prior period development the commercial MBR was 84.6%, which is approximately 300 to 400 basis points higher than comparable year-over-year and sequential ratios.

Our Medicare medical benefit ratio was 89.4%, 250 basis points higher than the prior year quarter, due in part to the risk adjusted premium revision which was worth approximately 190 basis points. We have reflected our current experience, including recent medical cost trend, operating metrics and payout patterns in estimating June 30, reserves

These updated assumptions resulted in a strengthening of health care reserves by approximately $60 million. These reserves, which include an appropriate provision for adverse deviation reflect more conservative assumptions as demonstrated by the following: health care cost reserves increased 3% during the quarter to $2.8 billion at June 30, relative to a 0.5% sequential increase in health care premium and sequential commercial reserve growth of 3.7% outpaced commercial premium growth of 0.9%,

Days claims payable decreased 0.4 days during the quarter from 41.6 days at March 31 to 41.2 days at June 30. This sequential change reflects a normal seasonal decrease offset by the reserve strengthening.

The third key component of operating margin results is operating expense efficiency.

We achieved a second quarter business segment operating expense ratio of 16.7%, representing a 160 basis point improvement over the prior year quarter. Approximately two-thirds of this improvement is due to operational efficiencies and fixed cost leverage despite continued investments for future profitable growth.

The remainder is due to an updated view of variable compensation that is commensurate with our revised full year outlook. Second quarter medical membership was generally stable, increasing by 14,000 members. Commercial membership decreased by 64,000 members. Medicare membership increased by 4,000 members and Medicaid increased 46,000 members. The 64,000 member decline in commercial membership included a 36,000 member increase in insured business which was more then offset by a decrease of 100,000 ASC members.

This change in total commercial membership reflected economy related in-group attrition of approximately 175,000 members during the quarter. The commercial ASC decline was driven primarily by in-group attrition in larger accounts. Commercial insured growth consisted primarily of gains in our individual business as our value added solutions continue to resonate with purchasers in that marketplace. Medicaid membership grew by 46,000 members primarily on an ASC basis.

The final area of financial performance I will comment on is our investment performance and management of capital. Second quarter net investment income on our continuing business portfolio, primarily healthcare and group insurance was $171 million, $3 million higher than the prior year quarter due primarily to higher average yields.

The investment portfolio had a very strong quarter demonstrating the high underlying quality of the portfolio and conservative nature of our investment strategy. The continuing business investment portfolio increased in value during the quarter by $632 million before tax, due to the major improvement in the credit markets and a corresponding tightening of credit spreads.

Turning now from liquidity and capital management; our financial position, capital structure and liquidity all continue to be strong. Our balance sheet metrics are excellent. As of June 30, we had a debt-to-total capitalization ratio of 30.2% and $6.1 billion of adjusted statutory surplus, more than $5 billion in excess of our regulatory requirements. We also continue to have a target risk based capital ratio of approximately 600% of the authorized control level.

During the quarter, we repurchased 10.9 million shares. Our basic share count was 436.5 million at June 30, down from 446.9 million as of March 31. We also continue to have very strong operating cash flow. Health care and Group Insurance GAAP operating cash flow for the quarter represented 47% of operating earnings, excluding pension expense. This lower cash flow is part of our normal seasonal pattern, reflecting two tax payments during the quarter.

Year-to-date Health care and Group Insurance GAAP operating cash flow represented 128% of operating earnings, excluding pension expense. On the same basis, we project operating cash flow to be approximately 130% for the full year.

I will now provide additional comments on our 2009 guidance. With respect to growth, we project year-end medical membership of slightly less than 19 million members, supporting double-digit health care revenue growth.

With respect to medical benefit ratios for the full year we project a commercial medical benefit ratio of 84% to 84.5%. This will result from a commercial medical benefit ratio that will average 84% to 84% for the second half of 2009. This increase of approximately 210 basis points from our June 2 to full year projection is comprised of the following: Approximately 50 basis points from lower premium yield; approximately 60 basis points from an increased medical cost baseline in prior period reserve development and approximately 100 basis points from increased 2009 trend.

It should be noted that the increase in our full year commercial medical benefit ratio guidance reflects a continuation of increased intensity, approximately 30 basis point for the H1N1 flu and assumes that the level of medical costs we experienced in the second quarter continues for the balance of the year. We also project a Medicare medical benefit ratio in the high 80's, consistent with prior guidance and our total medical benefit ratio is projected to be 85 to 85.5%.

Our medical cost trend projection is now 9% plus or minus 50 basis points, fully reflecting our second quarter experience. This 100 basis point increase reflects inpatient trend in the high single to low double-digits, outpatient trend in the low double-digits, physician trend in the mid to high single-digits and pharmacy trend in the high single-digits.

Our outlook also includes continued expense management discipline leading to a projected business segment operating expense ratio of approximately 17.6 to 17.7%, which represents a 60 to 70 basis points improvement over the prior year. While this may seem conservative, it does reflect a different spending pattern in the prior year. It also includes appropriate investments to address the issues we have discussed a new programs such as TRICARE, which position us to profitably grow our diverse portfolio of businesses.

We also expect to generate excess capital consistent with our revised earnings profile and project a year-end debt-to-capital ratio in the lower 30% range. Taking all revision to account, we project 2009 operating earnings per share of $2.75 to $2.90. This assumes a 2009 weighted average share count of approximately 450 million shares.

We are also in the midst of developing our 2010 operating plan. While it would be premature to provide an outlook for next year, at this early stage we are planning to improve our margin profile and if necessary we would be willing to forego membership growth to do so, price each customer to an appropriate margin based upon our revised medical cost trend outlook and realign our administrative costs and level of investment spending with our current operating earnings profile.

We believe that a consolidated pretax operating margin target in the high single digits is achievable and sustainable. 2010 will be the first step in returning to that level.

I will now turn the call over to Mark to provide additional inside into the operational factors impacting our second quarter results and the actions we are taking to improve future performance. Mark?

Mark T. Bertolini

Thank you, Joe. This morning I will provide insight into the key drivers of our operational performance and discuss the actions we are taking to improve medical cost management, provider contracting and pricing going forward.

Based on our most recent analysis, our higher than projected commercial and medical costs were primarily the result of continued high agreement intensity, which includes a higher mix of services, meaning services rendered in the higher cost setting as well as higher cost services, when lower cost choices are available and more services for in-patient than out-patient counter and office visit. New network given diagnosis providers are rendering more tasks and procedures. These are especially prevalent in emergency room, ambulatory, laboratory and for other services. In addition, we experienced a higher than expected level of large claims in certain blocks of business.

In short the increase in our commercial medical costs was due primarily to the higher cost per encounter, not more encounters. Our analysis indicates that provider behavioral changes are a contributing factor to these increased medical costs. While, this behavior seems generally permissible under currently reimbursement arrangements, it does deviate from prior practices. It's being address to appropriate medical management provider contracting and pricing actions.

Aetna already has very rigorous medical management programs. From the strong foundation we are increasing the frequency and focus of these programs to achieve more predictable and improved results, while ensuring that our members continue to receive quality affordable healthcare. We've recently taken specific actions, including those in the following four areas.

First, for historic recovery actions targeted at areas of increased trends including facilities that have demonstrated increased facility based coding intensity such as emergency room billings. Second, new claim reimbursement policies consistent with evidence based clinical protocols. We've seen multiple procedures being done in the same encounter and as a result are implementing new reimbursement rules applicable to second and third procedures that are performed concurrently.

Third, increased utilization management activities at certain targeted facilities. Our inpatient utilization is in line with expectations. However we have noticed some outlying facilities, we will be increasing our utilization management at those targeted facilities.

And fourth, engaging in direct intervention with certain large provider partners to ensure contract compliance.

We believe these and other targeted medical cost management actions will help ensure we achieve a market competitive trend. And while we have confidence in the success of these actions, we have not reflected the expected benefit of them in our projections, consistent with the approach we took on our June 2 announcement. In addition, we continue to intensely monitor key environmental trends, primarily impacts due to COBRA and flu. To ensure that we have up-to-date information on these impacts, meant they are reflected in our pricing.

Since 2008 baseline experience and 2009 trend were higher than we projected, we did not fully capture higher medical costs in our 2009 pricing. With the benefit of six months of claim experience for 2009 dates of service, it is clear that certain blocks of business and accounts have been impacted more than others. These blocks of business are in limited geographies and industry verticals and are receiving focused attention in order to restore them to target margins. Where an account is not at target margins, we will price ahead of trend

This is consistent with our objective to price each customer to an appropriate margin. As we are entering the 2010 pricing cycle, we are targeting specific pricing actions and benefit design changes. We are rolling the forego membership growth if necessary in order to improve our operating margin profile. More than 75% of our member months payable will be priced consistent with our updated view of medical cost trend.

Our pricing action should begin to have a noticeable effect beginning in the first quarter of 2010 with the full effect realized during the last three quarters of the year. While we believe that the pricing discipline we are employing may result in higher customer terminations, we still expect sale successors to offset any terminations that may occur, thus resulting in relatively stable January 1st national account membership.

In summary, we take our responsibilities to our customers and our shareholders very seriously. My team and I have taken immediate actions to improve our results. We're committed to repositioning the company for success in 2010. With that I will turn the call back over to Ron. Ron?

Ronald A. Williams

Thank you Mark. In summary, I would like to close by saying, that although 2009 results are disappointing across many dimensions, our franchise is strong. We have a sound business model that with hindsight was not adapted quickly enough to a changing environment. We continue to expand into many new markets as part of our segmentation strategy and it builds a diverse portfolio of high performing businesses that will fair well in many healthcare reform scenarios.

We put the customer at the center of everything we do and our service levels continue to meet or exceed our target levels. Our brand continues to resonate in our key markets. We can, and will grow profitability. Finally I would like to thank our employees for their unwavering dedication in meeting the needs of our customers. Their continued to focus in putting the customer at the center of everything we do will help us to return the level of performance we and you have to expect from Atena.

I am confident that by working together we will improve our performance and create shareholder value.

With that I will now turn it over to Jeff for the Q&A portion of the call, Jeff?

Jeffrey A. Chaffkin

Thank you, Ron. The Aetna management team is now ready for your questions. We ask you to limit yourself to one question and one follow-up, so that as many individuals as possible have an opportunity to ask their questions. Operator the first question please.

Question-and-Answer Session

Operator

Thank you ladies and gentlemen. (Operator Instructions). We will take our question from John Rex with JPMorgan.

John Rex - JPMorgan

Thank you. My first question just, I am most surprised we can see a more significant reserve boost in the quarter, kind of given the more conservative buyers you're talking about as you look forward in the year. Should we -- maybe if you can talk a little bit to that in the 2Q itself and then should we expect to see reserves coming up more meaningfully in the second half of the given how you're positioning it?

Ronald Williams

John we strengthen reserves as we said by $60 million in the quarter. And we really took into consideration all of the higher medical cost experience we experienced in the second quarter into consideration. So we really do think we have a strong reserve position and adequate provision for average deviation.

I will also point out that we took that same experience in to consideration in our third and fourth quarter forecast. So in our forecasting we assumed no improvement in either pricing or medical cost experience for the balance year although, we will manage to a better outcome. So, I think we've a conservative outlook and a very strong reserve position at the end of the second quarter.

John Rex - JPMorgan

And then just I appreciate your comment on the 2010 and just and I realize this is going to be done on an account by account basis but for our purposes what would you be targeting, what should we be seeing in terms of kind of an average favorable spread? And kind of where will you end up in costs for the year, let's say it is 9% this year. What magnitude of favorable spread would you expect us to see as you are moving into 2010 across the entire book of commercial insured?

Joseph Zubretsky

Well John if you look at our financial statements you will see that in the first quarter we did have a negative spread between trend and yield of 300 bases points. That has grown to 700 basis points on a reported basis, but adjusted for development approximately 400 basis points. As I said, we've taken no improvement to that negative spread for the balance of the year. Although we are clearly going to price to a better outcome and that effect should have, should start to have effect in the latter half of the year and into 2010. So clearly, we do believe that the medical benefit ratio that we've currently posted can be managed through a better outcome.

John Rex - JPMorgan

Is the target kind of, what you think about in terms of magnitude of favorable spread those, as we arrive in 2010, should it be 100 bips? Should it be you know, kind of just, broad side of the barn target?

Joseph Zubretsky

We're not going to give 2010 guidance specifically, but we have said, we can manage this business to a high single digit up pretax operating margins. It will take us a few years to get there. And while some of it will be provided by fixed cost leverage to our SG&A ratio a lot of it will have to come from managing the medical benefit ratio toward better outcomes. So I think you will have to wait till later this year we will give you specific guidance on our medical benefit ratio for next year.

John Rex - JPMorgan

Okay. Thanks.

Operator

And next we will go to Carl McDonald with Oppenheimer.

Carl McDonald - Oppenheimer

Thanks. First question is the in the past when you have talked about recognition of unfavorable development you have always said that it would be very unusual to see that development occur in say June, was there something different that led to the later recognition this year or do you think the, we are going to see elongation of the claims cycle time.

Mark Bertolini

Well. I think in terms of the favorable development -- unfavorable development we have seen one of the categories that we've talked about is that these are claims that are not typically very large claims but they tend to be in the $25,000-$30,000 range and so they are coming in slower than normal in the context of the quantity of them. And so the way we think them is the size of these claims has resulted in a slower level of development. And I think as we have recalibrated, we now understand what we are dealing with you.

Carl McDonald - Oppenheimer

Right and the second question; on the point about not assuming any improvement in the pricing, not assuming any improvement in the cost trend, what would you say historically has been the normal improvement, thinking around the loss ratio second half of the year versus first half of the year? I know we're in the commercial businesses for example, second half usually tends to be better than first half. Do you have any way to quantify sort of what the baseline is historically versus what your assumptions are for this year?

Joseph Zubretsky

Sure, Carl, if you look at historical medical benefit ratios by quarter, particularly 2006 and 2007 adjusted for development. We typically have had a high MBR in the second quarter and the second half of the year has been markedly better by perhaps over 100 basis points. Last year, our seasonality pattern was different. The uptick in the second quarter persisted through the second half of the year and conservatism would say, we are continuing that trajectory this year. So we are going to assume that we are not reverting back to historical seasonality patterns, but are going to forecast a seasonality pattern of 2008.

Carl McDonald - Oppenheimer

Got it. Thank you.

Operator

And next we'll go to Scott Fidel with Deutsche Bank.

Scott Fidel - Deutsche Bank

Thanks, first question just if you can talk about the impact from COBRA in the second quarter, the penetration levels and whether you're seeing an uptick in take up rates and then also what you're incorporating for your assumptions in the back half relative to the COBRA piece?

Joseph Zubretsky

Sure, our COBRA assumption really hasn't changed. We have seen an uptick in COBRA membership. We said it averaged 1 to 1.5% historically and that's over 2% now. We also said that the medical benefit ratios in that business are between 150 and 200% and they continue to be. So as part of this revision to guidance, we have not revised our COBRA outlook at part of this revision. So the year-over-year impact but not a revision impact.

Scott Fidel - Deutsche Bank

Okay. Then just to follow-up just two pieces around the Medicaid business and one just with Swine Flu you have updated us on the 30 bip increase for the year, did you start to see to see that in the second quarter or are you assuming that all starts to play out in the back half and then relative to medicate are you seeing any cost pressures, just relating to changing business mix as you see more previously uninsured or commercial members a start to commit and medicate program?

Ronald Williams

Scott in the H1N1 issue, we had approximately $15 million pretax of incremental flue related medical expenses in the second quarter and we are projecting that to increase in each of the third and fourth quarters.

Mark Bertolini

Scott we would, I would also add there in the flu, we are projecting a severe fall flu season. So we have that in our numbers as has been widely reported in the press. On the Medicaid front, we're seeing pressure from two perspectives. We're not seeing the same level of behavior on the part of providers in the Medicaid business.

However, we're seeing some discussion at the state levels around funding, as they try and figure out how to meet the needs, their budgetary needs and their deficit needs state-by-state. So we're having those discussions across the country as they wrestle with how to put together their budgets for next year.

Scott Fidel - Deutsche Bank

And then in the background the changing business mix in terms of durational impact with previously uninsured shortcoming in.

Ronald Williams

Repeat your question please.

Scott Fidel - Deutsche Bank

Just around cost trends in Medicaid, if you're seeing any impact from higher utilization or pent up demand from new Medicaid members coming in that were previously uninsured are coming in from the commercial market.

Ronald Williams

We always see that pressure to some degree of people coming in from being uninsured and we factor that into our annual rates.

Scott Fidel - Deutsche Bank

Okay, thank you.

Operator

And next we'll go to Justin Lake with UBS.

Justin Lake - UBS

Thanks good morning. Two questions; first on the just a little bit follow-up on previous question on margins. I calculate something around 6% maybe a little higher for your 2009 margin and when you talk about high single-digit, just talk about precise to think like anywhere from seven and nine from this period. Can you give us an idea in maybe if it's a 100 basis points, 200 basis points going to basic points of margin improvement that you expect to get all these business over period?

Joseph Zubretsky

I think by high single-digit I think 79 is a good range and at this early stage while we are not prepared to give year-by-year guidance of how we are going to get there but we clearly believe that in two to three years, we can improve our medical benefit ratios and improve the pre-tax operating margins to that range. A little too premature to give the step-by-step process how we are going to get there. 2010 is first year reposition of both the business from an underwriting point of view and containing the medical management growth and we believe that that will be a meaningful step toward that goal.

Justin Lake - UBS

Okay. And then secondly on the guidance revision just my quick math here gets me, you guided down $0.80 the change in the commercial MLR guidance plus what looks like a slight improvement in operating expenses gets me to somewhere around $0.50 to $0.60. I am just wondering what other guidance unless I am mistaken must some mistaken I don't know one other guidance points you might have changed as far as to get you down near the.20 to $0.30.

Joseph Zubretsky

The range is around everything on our outlook. I think you have it captured appropriately, most of the decrease in our earnings per share is commercial medical benefit ratio related and yes there is a slight pick up in SG&A, I would say that the imprecision around your estimate is probably in pretty ranges around various numbers.

Justin Lake - UBS

Okay. So there is no other moving parts?

Ronald Williams

No.

Justin Lake - UBS

As far as...

Ronald Williams

No. small ups and downs but that captures the essence

Justin Lake - UBS

Okay and thank you.

Operator

And next we'll go Ana Gupte with Sanford and Bernstein.

Ana Gupte - Sanford and Bernstein

Yeah thanks, good morning. My question is about the pricing action that you're doing for 2010. What is your trend estimation for the 2010 plan, are you assuming that is 9 plus or minus 50 bips at a higher run rate or you know cost trend or are you assuming all these improvements you're doing to medical management billing et cetera, now going to factor into the 2010 estimation?

Ronald Williams

We are pricing to the medical cost trend that we see within objective of achieving the target margin associated with each case and we are not assuming the impact of the medical cost actions and other actions that we've described.

Ana Gupte - Sanford and Bernstein

Okay, thanks, and I just want to follow up, it sounded like this time around, as you see of claims experience coming in, that there is adverse claims experience, it sounded like in certain blocks of business and is that into small groups and are you sort of changing your underwriting actions going into 2010 to become more conservative or are you going more around the lines if you can estimate health risks within each block of business and then price each block of business to translate that for me if you will?

Ronald Williams

Well I think, one of the things I would start out with is and we've talked about the increase in some of the vertical markets. These are not new accounts. These are not accounts that we have added fairly recently. I think in the context, I'll ask Mark to respond more specifically.

Mark Bertolini

Sure, a couple of things. First prices isn't the only lever. However we are going to price to the 9, plus or minus 50 bips plus any adjustments for things like state regulations, including things like the Mental Health Parity and we're rolling forward and we're not assuming any saves on the medical cost side. Then as we look at each book of business, obviously each book of business is priced differently. The small group being priced as a block and the case as we mentioned earlier in verticals and blocks of business are not directly related to any large block of business, likes small but relatively small group of customers and a small amount membership it wouldn't edictally describe the total change in MBR.

So, I wouldn't focus on that as a key driver. But as we re-price each block of business and each account we will move them to the appropriate margin and where we have to price and how trend to get them there we'll do that. Obviously, we'll be able to also use plan design in different price points and be able to impact the net out of pocket costs to the employers to go forward. And that's where we will have to be very careful on the underwriting program we are using and the way we consider benefit buy downs and decrements associated with taking people to leaner plan designs.

Ana Gupte - Sanford and Bernstein

Okay, thanks Mark.

Operator

And next we will got to Matthew Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs

Yes. Thank you. Question here on the, how we think about the earnings run rate. So if I have done the math right your new guidance implies an annualized EPS run rate in the back half of the year of about 225 to 250. Number one, is that right in and what should we think about in terms of the moving parts for that run rate being representative or not representative of where you are going into 2010 and that would include the pension expense components?

Joseph Zubretsky

Sure Matt. While we are not providing 2010 guidance at this early stage, we believe that any analysis you do should start with the full year 2009 earnings per share. Use that as the base and second half keep in mind is depressed with the higher medical cost, we experienced in the second quarter run rated through the last half, without any offsetting improvements and prices that we planned for 2010.

Also bear in mind, that we have the higher SG&A spending in the second half. And we have several investments that we're making for 2010, including Tricare. So our view is that the full year 2009 is a very reasonable and reasonable approach to looking at the base line of the business.

Matthew Borsch - Goldman Sachs

And then on the pension expense question, in terms of how we might think about that going into next year.

Joseph Zubretsky

Right now, till it's a little early to start doing pro forma calculations. But, if you just look at the market movement on the assets and where credit spreads have gone vis-à-vis the discount rates, right now our view is that 2010 pension expense would not be any different in 2009. But as you know, that's spot rate at the end of the year in terms of where the markets go and it's much too early to tell.

Matthew Borsch - Goldman Sachs

Okay, thank you.

Operator

And next will go to Doug Simpson with Morgan Stanley.

Doug Simpson - Morgan Stanley

Good morning everyone. Obviously the event of last two months has played a little differently then you'd originally expected. Just trying to gauge your level of confidence in your outlook, given the change in thinking couple of times over the last couple of months?

Ronald Williams

Well. I think I would say that we are comfortable with where we are. And I think that as we watch what developed as we closed June, we developed a much clearer sense of the impact of these macroeconomic conditions in terms of the utilization patterns. We've talked about the impact that we've seen from provider and the intensity of services both in the outpatient and the inpatient setting and we put in place we think a series of very robust actions but we are not forecasting those actions as we go forward. We also as we described have taken the second quarter medical costs as we are seeing it and using that as a basis for the full year projections.

So I would say, we have at this point a high degree of comfort.

Doug Simpson - Morgan Stanley

Okay, so if, last time we chatted was early June, subsequent to that you continued to see this deterioration, is it that your sense of things have stabled off now, stabilized, now what sort of baseline from here moving forward, just trying to gauge what's the potential inflection there if things persisted that -- in that same trajectory?

Ronald Williams

Well, I would start off as we believe we've a much better sense of the 2008 base line, which is a fundamentally important part in giving the inflection that we saw at the last part of that year, given the change in employment. And I think that one thing, as we try to describe, was not having a complete understanding of the impact of people going into a layoff situation, being on severance and the general mindset of consumers as they begin to worry about the employment. So getting the base line right was extremely important.

I think also we now have an understanding of the provider behavior component of this in terms of intensity and both understand it and are putting in place a series of offsetting initiatives. So I think those would be the major points along with the pricing component. So, we think we are stable.

Doug Simpson - Morgan Stanley

Okay. And then just on Medicare, could you just update us on your thinking there what's you've learned in the last 6, 7 weeks on that front. You've talked in early June about pressure on margins there. Just how do you feel your confidence, you give us a sense your confidence in the 2010 risk strategy?

Mark Bertolini

Doug, this is Mark. On the call on June 2nd, we described a take down in risk adjusted revenue which impacted our MBR's for the Medicare business. While we have seen some of the same kinds of pressures in the Medicare business that we've seen in the commercial block, not nearly as severe and quite frankly, given here the economy is and the fact that in the Medicare population employment's not a concern around use of services. We've seen it somewhat muted and have fully forecasted that prior to pulling our 2010 pricing in for June 1.

Doug Simpson - Morgan Stanley

Okay, thanks.

Operator

And next we'll go to Charles Boorady with Citi.

Charles Boorady - Citi

Hi thanks, good morning. My first question, just what factors led to the delay in getting a good read on the baseline for 2008. For example were there systems changes or any major contracting changes that made it take longer than normal to get that read?

Mark Bertolini

Charles, I think Ron described it before, you know when you're reserving into a rising trend and your latest month's pick is only 30% complete as to paid claim data, you know your view of trend is very important to getting an assessment of appropriate reserve levels and therefore your baseline. That was exacerbated by these, what I'll call mid-tier claims. These are not catastrophic claims, right in the 10 to 50,000 range due to the higher intensity that just by their very nature are getting reported later. And I think those two factors combined with the reason that our view of the 2008 baseline emerged far later then we would have liked, and far too late to have captured in the 2009 pricing.

Charles Boorady - Citi

Got it, and my second question is what is your current prediction on the seasonality of the business that's built in to your guidance for the back half of this year. Your original guidance stood out versus your peers, is not assuming, been kind of higher loss ratios in the back half for the year as they were. And I wonder is your view on seasonality changing and is that reflected in your guidance in addition to the factors that you already mentioned such as the higher baseline and the provider behavior.

Ronald Williams

I think the way to think about it is at the higher end of our EPS guidance which would be the low end of our MBR guidance which is 84% for the rest of the year. That compares to an 84.6 factor for the second quarter with our reserve development. So some slight improvement, but not markedly. And if you go to the low end of EPS guidance where we projected 85% medical benefit ratio for the balance of the year, that's 40 basis points higher than the second quarter result ex-development. So we clearly have flat lines in medical benefit ratio for the balance of the year. As I said, forecasting forward the current run rate of the business pricing to that level or then trying to manage it to a better outcome.

Charles Boorady - Citi

The seasonality?

Ronald Williams

I mean the seasonality is all baked in there, whether it's CDHP, whether it's utilization, it's always baked in, and as I said, this is a real change from the seasonality patterns of 2005, '06 and '07, but is the same seasonality pattern we experienced in 2008 when we hit an inflection point on medical cost in the middle of the year.

Charles Boorady - Citi

Got it, thanks.

Operator

And next we'll go to Josh Raskin with Barclays Capital.

Joshua Raskin - Barclays Capital

Thanks, good morning. My questions are relates to run-rate as well as look at sort of the changes in guidance to the last 3 (inaudible) here. You added about 80 basis points for commercial MLR back in April and another 80 basis points in June and now 250 basis points today if I sort of add that all up, 275 bips, something about $800 million of pre-tax medical cost. I'm just curious how do we consider that run-rate obviously you broke out 60 million of reserve those thinking about 100 million of negative development.

But of that total 800 how much of that is more we would consider recurring in part of the run-rate and how much of that is we have got to catch up to where we should be?

Ronald Williams

Well. I think the way I can answer to that as we go back to guidance that we gave back in February which was approximately an 80.8% commercial medical benefit ratio and now we've guided to 84.5 that's an increase of approximately 370 basis points. And the way I would think about that as approximately half of that is related to trend and medical cost related factors and the other half related to prior period development and its impact on the baseline and also yield.

So approximately half and half trend and related medical cost, prior period development and it will be other half 370 basis point increased to our medical benefit ratio guidance from February 2009.

Joshua Raskin - Barclays Capital

Okay. Then and I think about that in to 2010 just trying to get sort of directionally you talked about higher SG&A cost, you talked about half of this 375 basis points being but I would consider not run rate in nature and obviously you have the Tricare contracts starting there, there is some offsets with lower comps expense this year et cetera but should we think directionally as 2010 EPS, assuming you get some of these pricing actions, should it be up from that 2009 baseline or is it, or is it still too early to know if it'll be up?

Ronald Williams

Josh, that's why we characterized it in the previous question that we think the full year earnings per share growth rate is actual reflective of a good base line for the business projecting forward. It's too early for us to give 2010 guidance, but we'd encourage you to use 2009 annual EPS as the base line, because as I said the last half of the year does have the recent most recent medical cost outlook baked in with no improvement either to medical management or pricing and does have an overburdened impact of some SG&A spending. So the full year is probably the best base line to use projecting forward.

Joshua Raskin - Barclays Capital

Okay, and then any comments on the Journal article about the PVM sales this morning?

Ronald Williams

Well I think obviously Josh, we do not comment on rumors and speculation. I think that we believe we have a very sound strategy around integration. We think its continued to differentiate us in the market place. We think that the overall strategy that we have was one of the reasons that we won the Tricare. I think as any publicly traded company we're always looking at how we can better serve our customers and create more customer oriented value. So I think we just don't comment on rumors and speculation and we are committed to our strategy.

Joshua Raskin - Barclays Capital

I guess with the divestiture of your PBM assets is here to way to make that work within the integration strategy.

Ronald Williams

Josh, as I said, we don't really comment on rumors and speculation. I think I pretty much tried to answer your question.

Joshua Raskin - Barclays Capital

Okay. Thanks.

Operator

Okay. We'll next move to Peter Costa at FTN Equity Capital Markets.

Peter Costa - FTN Equity Markets

Hi. Thanks. When we look at sort of this quarter and year compared to 2006, it's seems like a replay, you start off with some problem showing up in the first quarter and then by the second quarter, you realized what the problems were more significant sort of kitchen sink’ed, that looks like this quarter, you've got everything factored in, and then by third quarter of 2006 you kind of said well, you went too far. What's the odds that you're going to be saying you went too far in the third quarter this year?

Ronald Williams

Well, Peter I would say that we've rendered our best judgment about the impact of what we learned in June. And I think we've tried to characterize in a direct and straight-forward way how we're thinking about the rest of the year, and would leave it to others to reach their conclusions.

Peter Costa - FTN Equity Markets

Do you feel as though, your estimates are conservative. I mean if you go through the list you kind of, given yourselves lot of room, the severe flu, no pricing help this year, the 2008 trend pattern is going on now, do you think you have taken the conservative side of every assumption?

Ronald Williams

We did a very thorough analysis after we got to June close and looked at all the claim data, looked at all of our accounts and I guess the best way to characterize is that you have full accounting of all the experiences we've had and our best judgment as to how that's going to pay out for the balance of the year. Keeping in mind as I said repeatedly we are going to try to manage this to better outcome but it's not included any improvement in our forecast.

Peter Costa - FTN Equity Markets

Okay. Thank you.

Operator

And we will go Michael Baker with Raymond James.

Michael Baker - Raymond James

Thanks. My first question as it relates to ASC book and how our cost trend is shaping up in those relative to those situations we have trend guarantees in place?

Mark Bertolini

Sure, Michael, Mark Bertolini here. We have seen similar increases in the ASC book of business. And as we go through the year we constantly adjust our performance guarantees and have reflected some additional strengthening in those performance guarantees reserves in our forecast.

Michael Baker - Raymond James

Okay, and then my question was, if you would update us in terms of penetration in generics within the PBM?

Ronald Williams

We don't have that data right off hand this moment. Mike, I can tell you though that generic in our consumer direct book of business, generic penetration continues to rise as people react to the fact that they're paying full out of their fund and out of their deductible, penetration has met expectations so far this year from the standpoint of the number of people adopting the program that are in the program.

Michael Baker - Raymond James

Thanks.

Operator

And next we'll go to Greg Nersessian with Credit Suisse.

Greg Nersessian - Credit Suisse

Hi thanks, good morning. Joe, based on your comments, it sounds like the realized yields for 2009 appear to be about 100 bips below your original expectations. So you came into the year at about 8%. It sounds like it's coming in closer to 7%.

First question, is that correct? And then second what is more importantly you think about 2010 if you weren't able to realize the 8% this year what gives you confidence you are going to be able to realize those 9% plus or minus 50 next year, given potentially more competitive pricing environment with competitors pricing to a lower trend without loosing more membership than it appears that's built into your forecast?

Joseph Zubretsky

Sure. That's a fair question. And I absolutely assure you that in our strategy we take a full enterprise view on all the levels that you pull to drive profitability of the business, MBR being one of them. So we certainly have to be cautious over an account that has potential to reach it's target margin over one or two year period and that's having a positive contribution margin on the business to manage that account back to profitability, realizing that we don't want to get into a negative fixed cost leverage issue.

So we do have confidence that we have isolated the books of business and accounts in the segments that have pricing pressure and believe that we can work with those customer relationships and manage those back. So it's not the entire book of business, most of the book of business is already a target margin. So we're putting a reasonable end market competitive rate into the market place.

Greg Nersessian - Credit Suisse

Okay, and then just the second follow-up then, when you think about that membership mix setting at the next, I know you're seeing sort of flat enrolment on Jan 1. But should we expect to step up in the level of ASC membership versus risk going into next year based on the presumption most of the issues that you're experiencing are in the risk book?

Ronald Williams

Yeah, we're not giving 2010 guidance on mix. All I can talk about is January 1 where it looks like our sales activity is offsetting our lapses and for national accounts will pretty much be flat.

Greg Nersessian - Credit Suisse

Okay, so just flat national account, okay, thanks.

Operator

And next, we'll go to Christine Arnold with Cowen & Company.

Christine Arnold - Cowen and Company

Hi there. Did I understand correctly that you said 75% of your member months will be priced for your new view is that, does that mean 25% of 2010 is already been locked in?

Ronald Williams

No. I'm sorry. Repeat your question just one time.

Christine Arnold - Cowen and Company

Yeah. I'm trying to understand how much of 2010 pricing already been locked in given the comments that 75% of your member month will be priced according to your new view of medical trends. So does that mean 25% of 2010 pricing are already locked in. I'm just trying to I'm trying to figure out kind of where we stand with 2010 in terms of opportunity?

Ronald Williams

Yeah Christine and that is correct which means that 75% has either already been pricing committed with the revised book of medical cost trend or will be now that we have an information. So, and we think that's reflective of the in force premium. So it's a good number to use on how much of the premium base we can effect with this revised look of medical cost.

Christine Arnold - Cowen and Company

So conceptually, do we assume that 25% of your commercial book will continue to deteriorate next year because its price behind?

Mark Bertolini

We are, Christine, this is Mark, we did start to impact pricing as we realized we're having medical cost pressure in the first and second quarters. So I think the net impact would move over on the first two quarters of the year for that 25% of the block. But we are talking about our commercial membership to be priced, when we reflect the 75% and 25% split.

Christine Arnold - Cowen and Company

So you are saying that even but the 25%, there'll be an improvement on a year-over-year.

Mark Bertolini

There will be some improvement over move up on a sliding scale basis as we impact the pricing through the first two quarters of the year.

Christine Arnold - Cowen and Company

Okay, great thank you.

Operator

And we will take our final question from Tom Carroll with Stifel Nicolas.

Thomas Carroll - Stifel, Nicolaus & Co., Inc

Hi good morning. I have just have a quick follow-up on the H1N1 comments that you had. You mentioned that specifically as part of your trend outlook how much higher then “normal” is that by order of magnitude I mean are we talking double are you looking at 50% higher then a normal flu season?

Joseph Zubretsky

I can reduced the basis points in the MBR.I mean in terms of our revised outlook we think that flu was about 30 basis points in the full year commercial medical benefit ratio which would be incremental to a normal flu season.

Thomas Carroll - Stifel, Nicolaus & Co., Inc

How much incremental though, again kind of ballpark figure trying to get a sense of what we are going to see this year in here from your competitors?

Joseph Zubretsky

Well in dollars if you take that and what we experience in the second quarter which is approximately 15 and in the balance of year which we think is approximately $65 million on an annual basis incremental to what would be considered as normal flu season

Thomas Carroll - Stifel, Nicolaus & Co., Inc

Okay.

Joseph Zubretsky

Okay. Thank you.

Operator

And there are no further questions. Would like to turn the call back over to Mr. Jeff Chaffkin, for any additional comments or closing statements.

Jeffrey Chaffkin

Thank you. A transcript of prepared portion of this call will be posted shortly on the investor information section of Aetna website at aetna.com. If you any questions about matters discussed this morning please feel free call me or one of my colleagues in the Investor Relations office. Thank you again for joining us this morning.

Operator

That concludes today's conference. And we thank you for participating.

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